CIRC in MEDIA - July 2011

No magic bullet
Financial Express, July 26, 2011

Suparna Karmakar

In a bid to remove policy uncertainties and reverse the decline in FDI inflows into the country, DIPP has proposed the removal of sectoral caps for FDI, at least up to a limit of 49%. The proposal also appears to have been motivated by the recent media focus on the leveraging of regulatory arbitrage for financial gains by a minority, inactive Indian partner in a recent high profile telecom takeover.

The DIPP policy paper justifies the call for removal of sectoral caps, given the distinction between ‘ownership’ and ‘control’ that was instituted vide press notes 2 and 4 in 2009, by which the sanctity of such caps has been compromised. Other than soliciting public views on relevance of equity caps, the DIPP paper also highlights the ambiguity arising out of the differential treatment of investment in different sectors, and has indicated the desirability of a common approach; while the caps pertain exclusively to FDI in some sectors, in others they include both FDI and FII flows. Thus the department acknowledges that indirect FDI of up to 49% is permissible under the current policies in most sectors, and sees no harm in legalising this de facto position.

Prima facie, the DIPP proposal endorses a longstanding call for rationalisation and consolidation of India’s foreign investment norms, and its adoption will bring in much-needed simplification and transparency to FDI regulations, which could potentially reduce graft and political/bureaucratic rent-seeking. Hence, it is difficult to imagine that the majority of Indian businesses and analysts will record any dissenting note. But a more important question that needs to be asked is: Will this change enhance FDI flows in any significant manner? Based on the available analytical and anecdotal evidence, I am inclined to conclude that it may be not, unless other bureaucratic and procedural irritants are removed.

It is true that in the recent past, India has had the unfortunate distinction of being the lone fast-growing emerging Asian economy to have experienced a decline in FDI inflows, at a time when weak growth prospects in OECD countries have encouraged multilateral firms to diversify into the more dynamic Asia-Pacific economies. Although recent data indicate a reversal of the above disappointing trend, policymakers and analysts would do well to look at the disaggregated FDI data and try to work out the more proximate causes of the FDI reversal. Further, while it is easy to pin the blame on caps, it is advisable to look into the counterfactuals, and ask whether these caps play any statistically significant role in the FDI decisions of MNCs.

In the sectors where FDI is allowed, caps of less than 49% apply in insurance, defence, media and domestic airlines; for all other sectors barring a very few, applied caps are at 74%. On the other hand, as per available data, different industries that attract FDI are services (financial and non-financial), telecom, housing and real estate, construction activities and power. A Nomura India forecast is that FDI inflows should remain supported by several large FDI proposals in the oil & gas, metal and telecom sectors. Thus, given that the sectors of interest are already largely open for FDI, it is difficult to imagine that removal of caps will make much difference in actual flows (despite the fact that there is enough interest among foreign investors in Indian insurance, defence and media sectors).

It is undeniable that low sectoral caps send out unwelcoming signals to the foreign investor community, given that ease of entry has always been a necessary condition for those taking strategic cross-border investment decisions. However, these are usually not the determining factors (sufficient conditions) for the locational decision. All econometric analyses of determinants of FDI into India seem to suggest that it is the growth prospects of the economy and importance of the sector in the economy, and the overall business environment that determine location decisions of foreign investors.

Among the latter, as most surveys of ‘doing business’ in India indicate, it is poor infrastructure, lack of transparency in regulations, red-tapism and ad hocism in policy implementation (including retrospective implementation of laws) that are the key deterrents for foreign firms operating or waiting to invest in the country. Thus, while the suggestion to remove sectoral caps up to 49% is laudable and would go a long way in improving the image of the country as a favourable investment destination; if the main objective is to enhance the FDI inflows in any significant manner, the government needs to retrain focus on creating an amenable business environment in the country.

A non-judgmental view is that it is the spate of corruption cases in 2010 (in construction and telecom sectors) and the dilly-dallying by government on approvals in key investment proposals (notably in the mining sector) in the last couple of years that has dampened investor interests in India. It will, therefore, not be wrong to surmise that simplification and fast-tracking of the approval processes, a relaxation and fair implementation of regulations, and a general improvement in the physical infrastructure and moral fabric in the country will attract FDI in significantly greater numbers as compared to the relaxation of sectoral caps.

Suparna Karmakar is senior fellow, CUTS Institute for Regulation and Competition, and research adviser, CUTS International, Jaipur.The views are personal

This news item can also be viewed at: